This is an article from P1M3 How Profit is Created in the Pillar 1 Your Key Numbers.
How To Reduce Your Costs To Improve Profitability
Look At The Detailed List Of Your Costs
First, if you want to reduce your costs, you need to know what you spend. It’s very hard to think about challenging your cost base when you’re doing it as a way of abstract thinking.
Your accountant or your computer system probably provides a detailed break down so take a look at it and challenge the big numbers first.
Seeing how the level of costs compare can be a big eye-opener. It’s very easy to agree to increase costs – an extra person, a salary increase, a price increase from a supplier or a new discretionary cost.
Use the 80/20 rule to help you to focus.
Around 80% of your costs will be spent on about 20% of the account lines and with 20% of your suppliers.
Basic arithmetic suggests that your big cost savings lie in your biggest costs and these should be the first place to look for cost savings.
Don’t ignore the 80% of items that make up 20% of your costs. There may be some quick wins from costs you don’t normally notice because they are so small but when combined, they are worth having.
Three Types of Fixed Cost
You have three types of fixed cost.
The first type of costs are the regular items you keep having to buy…things like stationery.
It’s a decision to buy but you keep making similar decisions, almost as a routine. You call up your favourite supplier and buy the usual things.
The second type of costs are the automatic regular costs – these happen automatically without any conscious decision. They continue until you decide to stop them.
The big category in this area is your employees.
Your employees have to be paid unless you make the conscious decision to stop employing them and then go through the right procedures to end the employment contract.
It also includes smaller items like mobile phones, car lease costs, rent, electricity, telephone…
The worst kind of automatic regular payments to control are those that take the money straight out of your bank account and don’t send you an invoice to remind you the money will be taken.
Things like the old photocopier which broke and you meant to cancel the contract but you never got around to it. So money keeps getting taken out of your bank account.
The final type of costs are the one off decisions – you see something you want and you decide to buy it.
Like a training course for example.
Once the decision is made, it’s done and the money has gone.
The more control you have…and the more you have to make a positive decision before incurring costs…the easier it is to reduce costs.
Three Factors In Every Cost
There are three factors for every cost. It makes no difference whether it is a variable and fixed cost:
1. The amount you use
2. The volume you pay for and is wasted.
For example a café may buy 20 Danish pastries every day but if it only sells 16 and because they go stale very quickly, 4 are wasted.
3. The price you pay
Working back up the list to find cost savings,
- Can you buy at a better price?
- Can you cut back on waste? Are there things you still pay for that gives you little or no value, like the broken photocopier I mentioned.
- And can you use less of what you buy?
For example, I see a lot of lights left on when no one is in the room. Can you and your staff get into the habit of turning lights off? Or can you write on the back of scrap paper when making notes instead of using new sheets?
It may only save pennies but remember the old saying “Look after the pennies and the pounds will look after themselves.”
Take another look at why you are buying and ask yourself if the reason is still valid? Much of what we buy is routine. It is bought because you’ve bought it before but is there a better way to solve the problem?
If you do a lot of colour printing and you use inkjet printers and spend a fortune on cartridges, would a colour laser printing save you money, even allowing for the purchase price?
You need to get into a situation where you regular challenge costs and look for waste.
Zero Based Thinking
A technique I like which works well for costs and many other decisions is one I picked up from Brian Tracy.
It’s called Zero Based Thinking and for such a powerful technique it is very simple.
You ask yourself a question “Knowing what I know now, would I still…?”
So to apply it to your costs, ask yourself “Knowing what I know now, would I still spend good money to buy…”
Or “Knowing what I know now, would I still hire John?”
Your answer is revealing because if you wouldn’t buy if you were starting anew, you probably shouldn’t still be buying.
Cost Cuts vs Business Growth
It’s important to get the perspective right between cutting costs and business growth.
There is a saying “You can’t cut your way to prosperity.”
I agree with that.
There is much greater potential in most businesses to increase contribution than to reduce fixed costs.
I also know that for many, it is easier to spend money than to earn money.
Cutting costs is a short term, quick fix route to extra profits and often a necessity if you are trading below break even.
Maintaining a cost conscious way of life, to continually try to reduce waste and focus on return on investment is a great discipline.
Keep asking yourself “If I spend this money, what do I expect to get back?”
Adding volume and increasing contribution is the main focus of my Eight Pillars of Business Prosperity system and especially Pillars 3 to 6.
We’ll also look at increasing prices and creating extra value in Pillar 3 and there is a Hidden Profit module on pricing.
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